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OPEC’s Change of Heart

Published on: 30/09/2016

After a turbulence on the oil market that lasted for over a year, the Organization of the Petroleum Exporting Countries (OPEC) finally decided to take action and put a stop to the tumbling oil prices this past Wednesday.

The 14-country union that is OPEC agreed to cut its production levels by 1-2%. Even though this number doesn’t seem like much and it’s only been a few days since the decision was announced, we’ve already seen a 5% increase in the price of oil, meaning that the OPEC countries would soon be able to make huge gains again.

Since 2015 we’ve seen dramatic declines in the price of oil that were caused by a series of factors. For one thing, China’s economic slowdown meant the demand for oil was less than the expected amounts. To add fuel to the fire (pun not intended), the US perfected some of its oil extraction methods and found a way to sell oil at lower prices than OPEC, which forced the cartel to lower its prices in return in order to keep up with the competition.

One might quite logically ask “Alright, the economists have been talking about how bad it is to pump for oil that nobody’s buying for over a year, what took OPEC so long?” The answer to this question lies in the deserts of Saudi Arabia. The kingdom is the most powerful force in OPEC and as such leads the other oil producers by example. The Saudis believed they can win the staring contest with the US and convinced all the other OPEC member states to wait.

However, Saudi Arabia has faced some internal struggles as a result of this policy. Most notably, the kingdom reduced its government spending to harbor the losses from the low oil prices and cut wages. This has had a negative impact of the standard of living in the country, especially for the middle class. In addition, Saudi Arabia needs a bigger budget in order to fund its military campaign in the Yemen. It is likely that a combination of these factors is what motivated the country’s decision to finally take action and attempt to raise oil prices again.

The production quotas for each country have not been decided yet – we expect to learn those at OPEC’s next meeting in November. Some volatility is expected today as investors are cashing in on the price increase, as well as in the days around OPEC’s next conference.

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